The two R’s – RRSP and RESP tips for young couples

Like many couples with young children, Zahra and Irfan have some financial questions. “Overall we’re doing well, but sometimes I wonder if we could be doing better,” Zahra says.

Suhaag.com offered the couple the opportunity to talk to Rahul Bhardwaj, a financial planner at Om Financial* with over 17 years experience. After some discussion, they narrowed down their concerns to three areas: paying back their Home Buyer’s Plan loan, setting up an RESP for their two young kids and saving for a bigger home.

The Home Buyer’s Plan

When Zahra and Irfan purchased their first home in the east end of the GTA five years ago, they took advantage of that ubiquitous program available to all Canadian residents with a Registered Retirement Savings Plan (RRSP) – the Home Buyer’s Plan (HBP). This is available to all first time home purchasers, and allows both partners to borrow up to $20,000 each from their RRSP. The loan is paid back over 15 years.

This no-penalty deduction from an RRSP can be a great help to first time home buyers because the loan is, effectively, interest free and has a generous repayment period.

“It’s a very economical loan from the government. However, if you don’t pay it back, it becomes taxable income,” Rahul says. For example, if Zahra and Irfan borrowed $20,000 they must pay back $20,000/15 years = $1,333 every year, or roughly $111 dollars a month. Failure to do this means that their taxable income increases by $1,333 every year until they repay the loan. Since the main purpose of an RRSP is deferred tax savings, you’re robbing your future of potential income, and your present of tax savings.

“There are no shortcuts to paying it back. Just add it on to your regular budget and make it a priority. Pay the loan first before contributing anymore to your RRSP,” Rahul counsels.

Setting up an RESP

Zahra and Irfan have two young children, and they hope to pay for university in the future. According to GlobalRESP.com, in 2022 a post secondary education in Canada will cost $61, 971; even more if they live on campus. Still, it’s better than our cousins down south, in the US. According to Forbes,“The College Board projects that in 15 years, the cost of a four year college education at a private university will approach $400,000 (at the current rate of cost increases).” (Forbes.com, Louis E. Lataif, 02.01.11)

A Registered Education Savings Plan (RESP) is a great tool offered by the government to help offset rising education costs.

“There are two types of RESP,” Rahul says. “The first type is a group RESP or scholarship plan. This type of investment takes advantage of pooled income and group investments. It is very conservative, as they invest mostly in government bonds, secure mortgages and GIC’s.” Earlier scholarship plans were criticized for being too rigid about the options available to students. But due to increased competition, the rules have become more relaxed.

“The second type of RESP is a mutual fund. This type of fund has the potential of better returns, but it depends on the market, which right now is pretty volatile. However, you have more control over your investment.” The general rule about an RESP applies to RRSP’s – the earlier you start, the more time you have to grow your money, and take advantage of government grants.

“Before the government would add 20%, but now it depends on your income. For lower income families, there is additional money available.” This means that for every dollar you contribute to your child’s education fund, the government will add $0.20, up to a maximum contribution of $400 every year per child. The maximum you can contribute is $4000 per year, but the government applies the grant on the first $2000. An RESP will net $7200 in government grants over the lifetime of the plan. Any missed contributions can be made up later.

One thing to keep in mind – unlike an RRSP, there is no tax deferral in an RESP and you can’t claim it on your tax return. The money is withdrawn when your child enters university, college, or an apprenticeship program, and they will be taxed on the income. However, only the interest or growth on the capital is taxed, and since students usually have no other significant sources of income, the tax rate is minimal.